The insured retirement solution

If you are like most business owners, one of your major concerns is finding legitimate and safe ways to defer and save income taxes. The Canada Revenue Agency (CRA) has recently closed most legitimate loopholes to allow tax savings. The average business owner who maximizes a personal RRSP is left with few other strategies. This has led wealth management companies to pursue alternative means of helping business owners save money from undue taxation.

One such method is the Insured Retirement Solution, a strategy which uses the stated tax treatment of certain financial vehicles, namely Universal Life insurance, to defer taxation and generate tax-free income at retirement.

As stated in the Pricewaterhouse Coopers Tax Planning Checklist, published by CCH Canadian Ltd.:

"Those looking for tax shelters or deferral mechanisms may wish to explore the significant benefits that may be derived from an "exempt" life insurance policy. While professional advice may be needed, it is to be noted that a substantial portion of the income from such investment accumulates free of tax, that such income can be utilized before death, and the proceeds are not subject to tax on death ...such policies may be a powerful tool in the tax planning arsenal."

How does it work?

The CRA stipulates that all investment earnings generated within the cash value of a universal life insurance contract are tax exempt; in other words, any investment income generated in these policies, whether capital gain, interest or dividends, is not included on your annual tax return. This allows excess capital invested in these programs to grow and compound without incurring taxes each year. A universal life contract has the potential added benefit of providing a sizable tax-free estate to your beneficiaries should you pass away prematurely.

So when do you pay taxes?

If you cash out of your plan, as with all deferral type investments, CRA would calculate how much you have invested into the program (called your Adjusted Cost Base or ACB) and how much it is worth now. You would pay taxes on the difference. However, the Insured Retirement Solution can be combined with a borrowing strategy. The cash value in the program can be used as the collateral you bring to a lending institution to establish a line of credit. The line of credit would be a cumulative type (all interest is added back to the principal owing) so that you don't have to make payments on the outstanding borrowed amount. You would then draw down on the line of credit each month to provide income to you and your family. Since borrowing money from a line of credit is not considered taxable income by CRA, all this income is essentially tax-free.

When do I pay back the line of credit?

Since there is a stated death benefit in the Insured Retirement Solution, you would make the lending institution holding your line of credit one of your beneficiaries on the policy to the extent that you have an outstanding loan. Upon death, the death benefit of the policy comes due and pays off the outstanding balance of the line of credit. The remainder of the death benefit then goes directly to your named beneficiaries.

Case Study

Sam is a business owner who maximizes his RRSP each year, and wants to invest an additional $10,000 per year for retirement. He is 48 years old, does not smoke, plans to keep working until he is 65, and then draw from his investment plans. Here is how the Insured Retirement Solution would work for Sam:

Assumptions:
Rate of Return: 6%
Borrowing Rate: 8%
Amount of insurance: $230,000
Death at Life Expectancy: Age 82

At age 65

Cash value of Insured Retirement Solution: $ 278,763
Death benefit of Insured Retirement Solution if death occurs at 65: $ 486,780
Income per month from the line of credit: $ 1,513 (assuming Sam wants this income)

Assume Sam passes away at 82

Total death benefit: $ 948,410
Outstanding balance of line of credit (8%): $ 642,076
Net tax-free proceeds to beneficiaries: $ 293,774
Total amount of tax-free income derived from the Insured Retirement Solution: $ 290,448
Before-tax income equivalent (assuming a 45% tax rate): $ 474,776

Benefits:

• Sam has accumulated excess capital in a tax exempt financial vehicle
• He has derived $ 290,448 of tax free income
• His beneficiaries received $ 293,774 tax free
• He only invested $ 170,000

However, a word of caution: The Insured Retirement Solution is a long-term program and affords very little liquidity to participants, especially in the early years. An Insured Retirement Solution may be for you if you have maximized your RRSP, paid off your non tax-deductible personal debt, and have money you wish to accumulate for retirement. If you would like to find out if the Insured Retirement Solution would be suitable for your long-term strategy, please call our office for a complimentary consultation.